Intra-African trade: Where are the opportunities?

BY ANDREW SKIPPER

Andrew Skipper is Partner and Head of Africa,

Hogan Lovells

It is a refrain that Africa's way forward has to be based to a substantial degree on Intra-African trade and that this is a key way in which Africa will Stand Up. Currently this is growing but accounts for as little as 10- 12% of overall trade on the continent, whereas trade with non-African countries is more than 50%.

In other developed economies such as the EU, intra-continental trade accounts (pre-Brexit) for over 60% of all trade, highlighting the obvious disparity. What is a realistic objective for growing intra-African trade by 2025 and how can key stakeholders help to achieve this?

What are the biggest barriers to intra-African trade?

It has been said that it is easier to travel in Africa on an American passport than an African one. Internal barriers to transit, for people, goods and services, materially inhibit growth. In turn this limits the opportunities to develop scalable supply chains within the continent, without which investment is almost impossible and bankable deals are few. Clearly the increasing influence of the current trade blocs and NEPAD are focused on breaking down these barriers.

Indeed, the OHADA region and common currency shows a good way forward. However, scale and transit remain major problems and need to be addressed by a combination of public and private sector investment and facilitation. Supply side constraints need to be considered in the round as many jurisdictions do not have established and successful regional value chains which allow and promote effective intra-African trade. These constraints are at the same time policy driven (eg tariffs) and simply logistical through lack of basic infrastructure, including road rail and power.

This is not a simple problem! Agriculture or agribusiness and light manufacturing with diversification and a clear imperative for adding value in the supply chain on the continent are increasingly a strategic focus for African governments as well as its growing, youthful workforce, which is estimated by McKinsey Company to add approximately 24 million people to cities on the continent and increase productivity. These factors if managed can be leveraged to give African states a competitive advantage both internally and outside the continent, but only if the produce can effectively be made, value added, moved and sold.

In other areas it can be argued that Africa does not promote intra-continental trade over extra-continental business in practical terms. Private firms on the continent face higher borrowing costs which severely hampers growth.

The African Development Bank estimate that Africa’s micro, small and medium-sized enterprises (MSMEs) in the formal sector lack financing. They face a credit gap on the order of USD 136 billion. Long term financing and private equity funding is rare. Private firms on the continent face higher borrowing costs because of a perceived increased credit risk in intra Africa trade -- which hampers growth. There is an increasing need for new solutions to traditional bank credit and traditional financial service providers are overly avoiding taking risks in financing, in particular SME's.

There are strong arguments for improving the variety of financing structures and improving the business environment for financial services and increasing the variety of funding products available. Regulators should recognise the different types of funding institutions and legal frameworks should differentiate between private funds, banking, co-operatives and micro-finance to promote lending.

New types of financial instruments will contribute directly to the growth of African firms and will diversify the financial solutions available to it. These include various types of private funds, debt instruments, crowd funding and impact investing for profit. Products like factoring can bolster cash flow and remove the need for using receivables as collateral for a loan.

Collaboration between development institutions, commercial banks and private funds can provide a mix of finance solutions and transfer risk to match the appetite for risk. DFI's tend to take a longer view on extending credit and private funds can provide seed capital and different forms of debt, and sometimes even equity, which in turn can satisfy the needs of a commercial bank.

Regulatory reform and interventions in many countries can create an environment for investors to be more comfortable taking risk such as timely insolvency procedures and strong contract enforcement.

Support for extra-African trade is not a new story. Governments do facilitate commercially attractive policies for extra-African trade; e.g. the subsidies available to African businesses trading internationally. For example, South Africa offers exporters compensation for the costs involved in developing export markets for South African products and services.

Whilst this is understandable in driving exports, in some cases it is currently more expensive for African countries to trade with each other than to export goods internationally; e.g. the tariffs that exist when transporting goods from West to East Africa are more significant in some countries than those levied on goods imported from and exported to Europe.

Beyond this the simple physical barriers to development of trade require investment in infrastructure and power if they are to be removed. Again this works as a combined public and private sector initiative which has to be based on clear strategy band cooperation. The role of the public sector and DFI's in de-risking the projects to a reasonable degree to allow private sector investment and resource cannot be overstated, and as we can see from elsewhere access to capital is critical for regional country development. There is global competition for investment and no intrinsic reason why global banking institutions must focus on intra African trade investment, unless they are commercially sound.

Which kinds of institutions play a major role in supporting and facilitating intra-African trade?

The key issue is that any development of a scalable and successful development of trade has to be driven by a combination of stable strategic policy and clear investment by the public and private sector. In addition, it must allow for the development of business by SME's albeit that the influence and development of large scale African corporates remains key. So numerous institutions have a crucial role in promoting intra-African trade, including, governments, DFIs, development banks, regional trade blocs, private sector and regulators. Indeed, NEPAD has been set up to oversee and harmonise regional and national policies on market development and trade. There is no shortage of players keen to drive this forward and the prize is clear to all.

However, while all of these entities play a role in supporting and facilitating intra-African trade, they require co-operation and commitment both in agreeing and ratifying regional agreements and then implementing them rigorously in a consistent and long term manner which allows the private sector to have the confidence to invest and thrive.

How important are investor protection mechanisms when considering a free trade area?

Investors are increasingly taking into account the level of investment protection available when choosing where to invest.  This is particularly the case for long term investments involving substantial capital investment, which are common in the infrastructure, power, real estate, agriculture and mining and oil and gas sectors.  Having investment protections is a way of mitigating sovereign and political risk and can be key in parties being able to obtain finance for a transaction making it "bankable".

Key questions that we see investors asking at the time of entering into a transaction are whether investment protections are available and how an investment can be structured to ensure that criteria for protection are satisfied. For example, in some jurisdictions investments are required to be registered in order to qualify for protection. Investment protections, whether in the form of a multi-lateral-treaties (such as the Southern Africa Development Community protocol on Finance and Investment), bilateral investment treaties between states or local investment law are important to create an environment that is attractive to investors and facilitates economic growth.

Will a focus on intra-African trade actually alleviate poverty?

Growth in trade will increase GDP and locally generated added value profit which ultimately is of benefit to the poorest in society. There is less unrest, services sectors expand and with appropriate policy implementation, including tax recovery, a trickle-down effect with the rise of income levels and more individuals in the middle income level. Governments are saying the right things but there are immediate challenges, such as the price slump in West African countries and the delay in grasping the importance of the supply chain.

Raw materials export on its own has little impact on the fundamental issues. The success stories for East Africa are that the products traded across the region are processed goods and this involves job growth.

An understanding of the intrinsic link between promoting the supply chain, intra-African trade in manufactured products, job growth and alleviation of poverty is fundamental. And finally, the need for investment in education so that the growing population is capable of taking advantage of the growth and developments remains probably the most important, long term issue.